Why HDFC AMC finds greater value in large and  small-caps than mid-caps

How are you reading the market mood? Given the Fed stance and covid uncertainty, do you think it is time to reduce exposure to equity and increase it to debt?

The sharp rally in equity markets over the past 18 months can be attributed to low interest rates in the economy and strong earnings growth delivered by corporate India. The markets have priced in, to some extent, robust earnings growth expected over the next three years.

There is some uncertainty in the markets with respect to the Fed stance on interest rates and the new covid variant. We are still in pandemic period; any concerning news on this will cause volatility as we saw during the delta variant too. The Fed as well has communicated about tapering, so it is a known event. However, any abrupt complete withdrawal, etc., can cause short-term volatility. From a valuations perspective, Indian market capitalization is currently about 91% of GDP (based on CY23 GDP), which is within the range of 60% to 100% that it has been in, post global financial crisis. Further, it is worth noting that despite the sharp rally in 2020 and 2021, Nifty50 returns over the past 10 years and 15 years are about 11-13% CAGR, which is largely in line with nominal GDP growth. Investors must note that going forward, in our view, markets should be driven by profit growth outlook and one may expect returns from equities, over medium to long term, to be in line with overall economic growth.

What is the strategy that you would follow in the HDFC Multi Cap Fund?

We will follow a mix of top-down and bottom-up approach to stock selection. HDFC Multi Cap Fund will invest without a style bias and aims to capture opportunities across value, growth and turnaround companies. We will be benchmark aware with respect to sector weights and we will aim to have a wide representation of sectors across market cap. The scheme will focus on companies, which are likely to witness a steady and secular growth and/or see a turnaround in profitability and have the potential of being re-rated. The scheme will also aim to invest in companies which are market leaders and/or are gaining market share due to superior execution, scale, better adoption of technology etc.

Do you think a minimum of 50% allocation (25% each) to mid-cap and small-cap segments will make a multi-cap fund a risky bet? How would you look to reduce the risk?

Multi-cap funds, by mandate will have a minimum allocation of 25% of total assets each to large-caps, mid-caps and small-caps. Historically, different market cap segments have outperformed each other at different points in time. Out of the last 16 financial years (FY06 to FY21), large-caps have been the top performing market cap segment in six years, mid-caps in three years and small-caps in seven years. Thus, multi-cap funds provide a one-stop solution for disciplined diversification across market cap segments.

Although mid- and small-caps are more volatile over the short term, they also tend to create huge wealth over the long term. At a portfolio level, we will try to mitigate the risk by diversifying the portfolio across stocks and sectors. Our aim will be to invest in companies that are expected to deliver above average earnings growth and are available at reasonable valuations. We will also look for opportunities where there is scope for expansion in Return on Equity (ROE) of the business.

Given premium valuations of recent IPOs, how would you explain mutual funds, including HDFC MF, taking exposure to these new-age companies?

New-age platform-based businesses are in nascent stage and the opportunity or total available market is very large for them. The company which will emerge as the leader in respective categories is likely to have a material market share, pricing power and profitability over time. In this journey, many startups could fail too. However, we consider the risks and opportunities ahead, before taking exposure to any stocks.

What are the areas that are looking attractive on a risk-reward basis?

With a positive economic outlook, lower interest rates, deleveraging of corporate balance sheets (D/E ratio has fallen from 0.99 in 2016 to 0.71 in 2021) and sharp revival in earnings, we feel that going forward, one can expect a broad-based rally in markets. In the large-cap space, we feel that turnaround in the NPA cycle, revival of telecom sector, digitization wave and decarborization trend globally is likely to drive profits of large cap companies. In the mid and small-cap space, as we see the global supply chain shift away from China to EMs coupled with revival in capex cycle in India, companies in the industrial manufacturing sector are likely to benefit. Further, which are part of the PLI scheme and fall in the mid- and small-cap segments are also likely to see good growth. Over the next 3-5 years, we can expect a broad-based rally in the markets. In terms of relative valuations, we believe that valuations of large- and small-caps are more attractive compared to mid-caps.